The bond floor is the estimated value of a convertible bond as debt, with its equity conversion right removed. Also called its investment value, it is the debt anchor used to judge how much of a convertible's value comes from its contractual cash payments rather than its equity upside. A convertible trading close to that anchor can still suffer a substantial loss if the issuer's credit deteriorates.
What is underneath the floor?
The starting point is the remaining coupons and redemption payment, valued for the relevant issuer, maturity and seniority. A simple calculation discounts those payments at a yield appropriate for comparable non-convertible debt. A more explicit credit model can instead value payments conditional on survival and recovery following default.
These are alternative modelling approaches: adding a full credit spread discount on top of already credit-adjusted expected payments can count the same risk twice. Whichever approach is used, the estimate must reflect the contract's rights and restrictions. Issuer calls, investor puts, contingent coupons and subordination can change the appropriate debt comparison.
The result is a present value, not the face amount promised at maturity. It is also distinct from the conversion value, or parity: the current value of the shares delivered on conversion. With a fixed conversion ratio shares per bond and share price in currency per share,
Two anchors, one consistent valuation basis
Consider a fictional convertible with face amount USD 100 per bond. At the initial valuation date, its modelled bond floor is USD 95 per bond. Its fixed conversion ratio is 3 shares per bond, and the stock is USD 30 per share, so parity is USD 90 per bond. Assume no accrued interest at either illustrated date; all values use the same USD basis, and the conversion ratio stays fixed.
Comparing the anchors gives . That comparison does not price the convertible. The holder may retain valuable future conversion opportunities, and valuation must account for their timing, stock volatility, credit risk and the actual call, put and settlement terms. Nor should the anchors be added: USD 95 of debt value plus USD 90 of shares is not a USD 185 convertible. Conversion exchanges the debt claim for shares under the stipulated terms; the investor does not receive both claims intact.
Stipulated model snapshots, not market data or a convertible pricing curve. Both panels use the same value scale. The debt anchor falls from 95 to 70; no credit calibration is implied.
Why the floor moves
The later snapshot stipulates a bond floor of USD 70 and a stock price of USD 20, giving parity of USD 60. It illustrates a central risk: the equity can fall while the estimated debt support falls too.
For fixed promised payments, higher required yields reduce their present value. A wider credit spread, a worse recovery outlook or changed expectations about contractual payments can therefore weaken the debt anchor. Changes in market interest rates also matter. These drivers need not move independently of the stock.
“Floor” describes a valuation reference under stated assumptions. It does not guarantee a minimum executable sale price, repayment of face, or a fixed amount after default. Liquidity and financing pressure can also separate traded prices from model estimates. A price below yesterday's estimated floor is a reason to recheck the credit inputs, contract comparison and market conditions; it is not by itself proof of a riskless arbitrage.
For the calculation and premium measures around this anchor, Bond Floor, Parity and Premiums develops the debt present value and compares investment and conversion premiums. The full lesson requires membership; its public preview shows the scope.
Sources
- De Spiegeleer, J. and Schoutens, W. (2011), The Handbook of Convertible Bonds: Pricing, Strategies and Risk Management, Wiley, §2.2, pp. 26–27, and §2.3.1, pp. 32–33. These sections distinguish investment value from parity and show why credit deterioration can undermine the apparent floor.
- Calamos Investments, “Convertible Securities”, §4: Valuing a Convertible Bond: investment value, conversion value, theoretical value and the effects of credit deterioration.